Supermarket chains, sports training groups and other private- sector bodies will no longer be able to buy courses on the cheap using taxpayers' money.
Where courses are approved, FEFC cash will be slashed by a third. Firms will have to pay at least half the bill for staff-related training.
David Melville, FEFC chief executive, said: "Colleges undertaking substantial franchising should not receive a windfall financial benefit."
The proposals were sent to all colleges this week. They follow damning reports from the National Audit Office, management consultants KPMG, the Commons education and employment select committee and FEFC inspectors.
Geoff Daniels, FEFC assistant director, said: "The intention is to reflect government expectations and send a clear message to colleges that the days of free-for-all franchising anywhere in the country are over."
David Blunkett, the Education Secretary, called for a halt to franchising. Reports showed it had led to huge expansion on the cheap in FE, but there was inadequate staff training and quality control in the flourishing national vocational qualifications market.
Under new regulations, colleges seeking franchise deals must prove that they benefit the local community, reflect the true cost of courses, meet strict external audit measures and adhere to strict new employment regulations.
Employers must contribute pound;20m towards costs this year, rising to pound;60m in 2001. Colleges must also set targets for additional employer contributions. Courses funded by the FEFC under franchise deals will get 37 per cent less cash than those provided directly by the college.